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LOBLAW IN CANADA’S STAGNANT GROCERY MARKET 1

Ruhama Quadir and Kelly Whitehead wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2017, Richard Ivey School of Business Foundation

Version: 2017-11-08

In September 2016, Loblaw Companies Limited (Loblaw) was at a critical deadlock. The company’s performance in the last quarter had been disappointing at best; food sales had grown modestly (2 per cent), but net income was down 14.6 per cent from 2015.2 In a Toronto Star article headlined “Can Weston Get the Blah out of Loblaw?,” the weak results were attributed to Loblaw’s “antique-like” business model.3 Bay Street (the centre of Toronto’s financial district; also used to refer to Canada’s financial industry), was more forgiving, as analysts’ consensus was to designate a “neutral” rating for Loblaw’s stock.4 However, the direction of the company’s future remained unclear, and competition in the grocery market was heating up. What should Galen Weston Jr., chairman of Loblaw, do to prepare Loblaw for a potential price war in the months ahead?

ABOUT LOBLAW (SEE EXHIBIT 1)

Loblaw was a subsidiary of George Weston Limited, the owner of such food and retail brands as Wonder Bread and Holt Renfrew.5 Based in Brampton, Ontario, Loblaw was Canada’s largest food retailer, with annual revenues of CA$45 billion6 in 591 corporate stores and 525 franchised stores across Canada (see Exhibit 2).7 Apart from its flagship Loblaws Great Foods stores, Loblaw managed the Real Canadian Superstore (large format supermarket), No Frills (discount supermarket), and T & T Supermarket (ethnic supermarket),8 among other banners. Further, in 2013, the company acquired Shoppers Drug Mart’s (Shoppers) 1,242 drugstores for $12.4 billion, beginning Loblaw’s foray into the pharmaceutical industry.9

HUMBLE BEGINNINGS

Theodore Loblaw opened the first Loblaw groceterias (self-serve grocery store) in Toronto in 1919. Predicated on a “cash-and-carry” concept, Loblaw was a venue for buying quality products in bulk at low prices. Shortly after, the company expanded to 70 stores in Ontario and ventured south of the border, to New York and Illinois. Loblaw’s fast-paced growth encouraged W. Garfield Weston, president of George Weston Limited, to invest heavily in the company during its early years. By the 1950s, the Weston family held a controlling stake in Loblaw.10

Authorized for use only by Michino Nobe in Strategic Management at George Brown College from Jan 10, 2019 to Apr 18, 2019. Use outside these parameters is a copyright violation.

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After decades of prosperity, a turn of events left the company nearly bankrupt in 1971.11 Galen Weston Sr., the grandson of George Weston, founder of George Weston Limited,12 scaled back Loblaw’s growth and streamlined operations through a multi-tiered strategy that involved (1) cutting 100 underperforming stores (out of 200 total stores); (2) hiring marketing expert Dave Nichol as president; (3) divesting non-core assets; (4) remodelling storefronts; (5) investing aggressively in advertising (Star Trek actor William Shatner appeared in the 1978 advertisements);13 and (6) diverting the company’s focus away from the U.S. market.14 Another key initiative was the introduction in March 1978 of the “no name” brand, a line of basic household products that were steeply discounted by 10 to 40 per cent relative to market prices15 and that quickly became popular among price-sensitive consumers. Months later, No Frills, Loblaw’s deep discount outlet, was born. By 1980, Loblaw had returned to profitability, and five years later, it stood as Canada’s grocery market leader. In the following decade, Loblaw’s private label, President’s Choice (PC), was available in 1,200 stores in 34 U.S. states. Loblaw even supplied products for Wal-Mart Stores, Inc. (Walmart) under the name Sam’s Choice before the latter grew its Canadian presence and the relationship deteriorated as the two became competitors.16 In 2006, Loblaw faced yet another storm when its Loblaws stores posted a $219 million loss. The Weston family’s leadership was instrumental in remedying the company’s ills. The family overhauled Loblaws’ organizational structure and distribution systems, and the stores quickly recovered. On September 14, 2016, Weston Jr. ascended to the role of Loblaw’s president, marking the fourth generation of Weston leadership at the company.17 “DEAR, PLEASE PICK UP SOME MILK AND A MORTGAGE”18

The development of PC formed a key advantage for Loblaw in that PC allowed the company to diversify its offerings and, therefore, its user base. While the no name brand spoke to price-sensitive consumers, PC was designed for Canadians at the upper echelons of the income spectrum. The private label first emerged in 1984 after Nichol, then president, introduced “President’s Blend Gourmet Coffee” to Loblaw’s shelves and was inspired to start a control label following the coffee’s unexpected success.19 Nichol leveraged his marketing background to showcase PC products through a magazine called the Insider’s Report, in which he shared his personal experiences with, and endorsements for, PC products. The Insider’s Report was widely purchased among Loblaw’s customers, likely because its informal, anecdotal advertising format made the PC brand relatable and desirable in the eyes of consumers.20 Long after Nichol’s departure in 1990,21 PC managed to retain its reputation for being a relatable and down-toearth brand. Weston Jr. himself regularly made appearances in its commercials to promote PC’s products; the best known was The Decadent, a chocolate cookie that outsold all Canadian rivals within three years of its 1988 release.22 The PC name was eventually tied to Loblaw’s attempts to penetrate new niche markets, including but not limited to organic products, baby food, and banking/insurance services. These diverse services sought to serve the vibrant Canadian population, which was characterized by rising household incomes.23 In 2006, Loblaw distinguished itself by unveiling a feature on the PC website (presidentschoice.ca) that allowed consumers to rate and review products, enabling feedback generation for both improving existing products and developing new ones. This move established the company as one of the first major grocery brands to integrate consumer-generated content into its website, and signified Loblaw’s continued commitment to adopting a consumer-centric orientation.24

Authorized for use only by Michino Nobe in Strategic Management at George Brown College from Jan 10, 2019 to Apr 18, 2019. Use outside these parameters is a copyright violation.

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As part of its later ventures into the digital arena, Loblaw decided to leverage the popularity of its PC brand to launch the PC Plus loyalty program in 44 stores in May 2013.25 At its core, PC Plus was a mobile rewards system that offered customized deals to shoppers on a weekly basis by analyzing patterns in their buying habits.26 The year also marked the announcement of the Shoppers acquisition, through which Loblaw inherited the Shoppers Optimum loyalty program, which had managed to reach one in every three Canadians since its debut in 2000. By November 2013, the PC Plus program was rolled out nationwide. Within nine months of its introduction, PC Plus had recorded a total of 6 million members and several hundred million dollars of revenue.27 TROUBLE AT THE TOP OF THE FOOD CHAIN

Although Loblaw’s 30.1 per cent market share in mid-2016 was a comfortable four points higher than the market share of the next leading competitor, food retailer Sobeys Inc. (Sobeys), recent market trends were not promising. In the 18 months leading up to May 2016, food inflation was above 3 per cent, and the adverse effects of this on fresh produce were particularly strong.28 Retailers’ efforts to protect margins contributed to astronomical price increases on the shelf (notably, a price of $10 per head for cauliflower).29 Weston Jr. assured consumers that inflationary pressures would soon desist,30 yet market researchers claimed otherwise. Although July 2016 saw inflation soften to 1.3 per cent, IBISWorld’s predictions set 2017 inflation to exceed 1.9 per cent, 30 basis points higher than the projected increase in total grocery revenue in Canada.31 In comparison, the country’s gross domestic product was expected to increase at 1.1 per cent, with 85 per cent of growth attributable to the provinces of Ontario, Québec, British Columbia, and Alberta.32 Although the public sector was often the beneficiary of support from Canada’s Liberal government in such circumstances, the same could not be said of the private retail sector. Growing consumer frustration eventually prompted Weston Jr. to announce on July 6, 2016,33 that Loblaw would “reject any future cost increases from suppliers”34 except those related to higher input costs, and would apply a 1.45 per cent cost decrease to shipments from September onward. A spokesperson mentioned that the move was not meant to be adversarial, but rather was intended to encourage suppliers to share the inflationary burden. Other parties begged to differ, pointing to 2014, when Loblaw was under investigation by the Competition Bureau for 12 files related to its treatment of suppliers.35 Loblaw’s troubles revealed the complex realities of the grocery business. On the one hand, supermarkets knew that fresh produce, household products, and other related items fulfilled fundamental consumer needs, thereby ensuring a steady stream of customers independent of economic conditions. On the other hand, Loblaw recognized that Canadians would only buy so many vegetables or paper towels. Further, Loblaw was hard-pressed to convince a consumer that its standard berries or apples were any sweeter or fresher than those of a low-cost competitor.

THE SUPERPOWERS OF THE SUPERMARKET INDUSTRY

Traditionally, the Canadian grocery market was dominated by Loblaw (30.1 per cent), alongside key rivals Sobeys (26.1 per cent) and Metro Inc. (Metro) (10.6 per cent).

Authorized for use only by Michino Nobe in Strategic Management at George Brown College from Jan 10, 2019 to Apr 18, 2019. Use outside these parameters is a copyright violation.

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A subsidiary of Empire Company Limited—which also owned Foodland, FreshCo, and IGA—Sobeys was a Nova Scotia-based grocer with 125,000 employees, 1,500 corporate/franchise-owned stores, and approximately $22 billion in annual revenues.36 Pharmacies, liquor stores, and gas stations also belonged to Sobeys’ broader offering, although in its earliest years, Sobeys operated solely as a meat delivery business serving the approximately 1,750 residents of Stellarton, Nova Scotia. In fact, it was not until 1947 that the company made its formal entry into food distribution with the opening of its first branded supermarket. Forty years later, in 1987, Sobeys claimed $1 billion in sales and established its first location outside of Atlantic Canada in Guelph, Ontario.37 In 2013, Sobeys announced its intention to acquire the 223 stores of its competitor Safeway Inc. (Safeway), which left Sobeys poised to become the market leader in Alberta—one of the largest markets outside of Ontario or Québec. Upon this announcement, the Competition Bureau demanded that Sobeys divest 23 of its stores; otherwise, the transaction could have been barred for being anti-competitive.38 Widely criticized as a move that damaged the brands of both parties, Sobeys’ takeover caused a substantial disruption to Safeway’s supply chain, which remained largely uncorrected even in 2016, three years after the transaction. In a detailed review of the acquisition published in July 2016, the Calgary Herald emphasized disgruntled customers’ experiences with advertised but out-of-stock items and consistently higher prices at several Safeway locations.39 The former pain point may have been tied to Sobeys’ decision to shift Safeway toward Sobeys’ own inventory policy, which involved stocking items merely three products deep—a stark contrast to Safeway’s pre-existing policy that heavily emphasized inventory replenishment to assure product availability. Also rumoured to have been linked to the takeover was the disbandment of Safeway’s Club Card loyalty initiative, allegedly done to align the acquired company with Sobeys’ Air Miles program.40 Additionally, Sobeys replaced Safeway-branded products with those of its own private label, to the chagrin of many western Canadian shoppers.41 At the height of its ensuing financial losses, Sobeys reported a shortfall of $2.1 billion as well as writedowns in excess of $2.9 billion, which prompted the departure of then chief executive officer, Marc Poulin, in July 2016.42 It was uncertain whether Empire Company Limited’s subsequent announcement that it would cut 1,300 Sobeys jobs in 2016 and 2017 was driven by the disappointing financial performance.43 Another possible explanation was that the restructuring would make room for new automated distribution centres in Calgary, Alberta, and Vaughan, Ontario, planned for mid-2017.44 Sobeys’ other maneuvers in the marketplace had, arguably, met with greater success. For instance, the extensive renovations aimed at rebranding its Price Chopper stores, which operated under the name FreshCo beginning in 2010;45 a partnership with renowned chef and healthy eating advocate Jamie Oliver;46 and the introduction of luxury-format stores in 2013 had all been applauded in the marketplace.47

Metro (see Exhibit 4)

Headquartered in Montreal, Québec, Metro owned and operated 338 supermarkets and 218 discount retailers in Québec and Ontario under the banners Metro, Food Basics, Super C, and Metro Plus. An estimated 258 drugstores also operated under Metro’s ownership. Prior to becoming a food retailer in its own right, Metro was a member of a group of independent retailers that emerged in 1947 to use their collective buying power to compete with major grocery chains.48

Authorized for use only by Michino Nobe in Strategic Management at George Brown College from Jan 10, 2019 to Apr 18, 2019. Use outside these parameters is a copyright violation.

Sobeys (see Exhibit 3)

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In October 2016, Metro planned to begin testing “My Online Grocery” in Québec, which would allow customers to have Metro’s fresh produce, meat/poultry, prepared meals, and other grocery items delivered to their homes or made available for pick-up in-store at a time of their convenience.50 The service’s key elements arguably mirrored those of Loblaw’s “Click & Collect” program introduced in October 2014,51 which had been rolled out at approximately 100 locations.52 The online grocery segment represented less than 1 per cent of sales in the Canadian grocery sector, a figure that was expected to rise to 3 per cent by 2018. Although pick-up services had been found to reap higher margins (13.8 per cent) than home deliveries (10.7 per cent), Metro and Loblaw offered both.53 Metro’s pattern of acquisitions emphasized high-quality premium segments. A primary illustration of such was its acquisition of a majority stake of the bakery chain Première Moisson in 2014, through which Metro expanded its selection of higher-end baked goods.54 Earlier, in 2009, Loblaw had purchased ethnic player T & T Supermarket; two years after, Metro followed suit when it bought a 55 per cent position in Québecbased Mediterranean retailer Marché Adonis.55 THE “BIG BOX” PLAYERS

Historically, the high capital requirements of the supermarket sector deterred prospective competitors, even though those who chose to enter the market benefitted from substantial scale economies. In recent years, however, Loblaw had seen unconventional competitors emerge—namely, warehouse clubs such as Costco Wholesale Canada (Costco) and Walmart Canada (Walmart) that competed on price. Marketline, for example, cited Costco as Loblaw’s primary competitor.56 Non-traditional players posed a serious threat to Loblaw’s core business, not only because competing against them necessitated lowering margins, but also because Walmart and Costco had extensive offerings of non-perishable items (e.g., pet products and fixtures). By tapping into the food retail space, these players effectively became one-stop shops for consumers who valued convenience and price. Costco and Walmart’s 10 per cent and 7 per cent shares of food sales in the grocery market, while small in comparison to Loblaw, were concerning.57 While Loblaw was putting pressure on suppliers to absorb cost increases, Walmart and Costco, through favourable contracts with suppliers such as General Mills and Kellogg,58 which had been negotiated owing to the retailers’ size and scope, had managed to continue to pass down lower prices to consumers.59 Revenue growth was expected to increase at an annual rate of 5.2 per cent, largely owing to the lower prices these warehouse players were able to offer their customers.60 In response to these competitive pressures, Loblaw announced its intention to allocate $1 billion to opening 50 new stores and renovating 150 existing locations in 2016.61 $1.2 billion was spent toward the same end in 2015.62 This investment was partially devoted to expanding “Inspire” stores—deluxe Loblaw locations in cosmopolitan hubs that featured premium merchandise. Loblaw, alongside Sobeys and Metro, also participated in a string of acquisitions. For instance, Loblaw acquired QHR Technologies, a medical records start-up,63 supposedly as part of a potential plan to distribute medical marijuana through its network of Shoppers stores.64

Authorized for use only by Michino Nobe in Strategic Management at George Brown College from Jan 10, 2019 to Apr 18, 2019. Use outside these parameters is a copyright violation.

As the youngest of the top three Canadian grocers, Metro’s focus was on expanding its fleet of supermarkets. Notably, Metro’s discount stores—despite having performed strongly—took a back seat in the grocer’s expansion strategy. Instead, Metro’s stores increasingly garnered a reputation for their valueadded services, including the My Metro mobile application (similar to Loblaw’s PC Plus application), beef aging rooms, fish smokers, and in-store bistros, among other “premium” features.49

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Founded in 1976,65 Costco was the leading operator in the Canadian wholesale club industry, with a formidable 48.5 per cent share.66 Beyond providing low prices on consumables, health and beauty products, apparel, and other merchandise through selective product sourcing (a typical Costco warehouse carried only 4,000 stock-keeping units compared to the 30,000 typical of supermarket peers),67 Costco also managed a faithful customer base. Having pioneered the retail “membership” concept, whereby customers paid an annual fee to shop at any of its 98 Canadian locations,68 Costco attracted over 10 million customers who renewed their membership at a 91 per cent rate.69 Purportedly in reaction to Walmart’s expansion of its fresh produce lines, Costco had grown its grocery selection substantially over the previous five years. The warehouse club’s private label, Kirkland Signature, offered consumable products such as extra virgin olive oil, organic...